SPEECHES & TESTIMONY

Washington, DC

February 15, 2006

Good Morning. I would like to thank the panelists that have come here to testify today and the Chairman for agreeing to convene this hearing on self regulation in the futures industry.

Self regulation in the futures industry has long served the market well as has been demonstrated by the success of the industry as well as, I believe, the relative lack of serious regulatory breaches in the industry. Yes, there was the FBI sting of the late 1980’s that raised significant questions regarding self regulation of the markets, but I believe that the industry learned a serious lesson from those events, stepped up to the regulatory plate and has moved well beyond the problems that the sting exposed.

Today, the SRO model of regulation in the futures industry seems to be working well, but as with any regulatory program, I believe that it is important that we periodically review its efficacy to ensure that the program has the right incentives built into it to effectively serve the market and public interests.

In recent years, the futures industry has experienced a sea change of innovation. Whereas the trading floor once served as the mechanism to bring traders, and those for whom they traded, together in the markets, today computer networks serve that purpose. The technology that has enabled this has had a profound effect on the global nature of the markets, the ownership structure of exchanges, and the ability of competitors to enter the markets.

New competitors no longer need to construct large trading floors or limit memberships to grant access to the floor. As a result there is the potential for many more competitors to enter the markets. Moreover, many of these potential competitors are currently members of the exchange and subject to the rules of those exchanges. And just as this technology has enabled members to become competitors, so too has the technology allowed exchanges to bypass the traditional member.

Self-regulation is vitally important to the U.S. futures industry and we must ensure that the regulatory model continues to serve us well in light of the dramatic changes taking place in the marketplace. Those changes, many of which are of very recent origin, have challenged some of the assumptions that underlie the SRO model. The fundamental rationale underlying self-regulation is ironically self-interest—that it is in the rational self-interest of exchanges to police their members so as to prevent abuses. Equally important is the notion that organized exchanges have strong incentives to adopt rules that benefit investors since their long-run profitability is a function of how well they serve their customers.

But this fundamental alignment of interests—which underlies the SRO model—breaks down somewhat when exchanges switch from member cooperatives to public corporations. Changes in industry corporate structure, to give one example, now permit exchanges to issue rules that affect their competitors. These changes have led to “the paradoxical situation,” as Professors Jonathan Macey and Maureen O’Hara have pointed out, where those who are in charge of self-regulation may be regulated by and are regulating their competitors.

We all know that when incentives change, so does behavior. Our task is to identify those specific areas where the incentives are such that self-regulation may be compromised in serving the public interest and to come up with fixes carefully tailored to allow self-regulation to work better.

As a result of these changes, and others, conflicts that once did not exist in this marketplace now do. As the oversight regulator of the futures industry, it is important that we focus on the well-being of these markets for the benefit of the public. We must be confident that the conflicts that exist, and steps taken by SROs to deal with them work to the good of the marketplace over the self-interest of the SROs. At times these interests may be aligned; at other times they may not.

I look forward to a robust discussion of the issues today, and would ask that as you develop your responses to the questions, you keep in mind that as we consider SRO structures, what we are really focusing on are the incentives that particular structures create to achieve a particular public interest outcome. What I look forward to is an explanation from the panelists as to how the particular structures they advocate create the proper incentives to best serve the public interest.